October 2008 Archives

There is a crucial difference between a meltdown and a slowdown. Like the difference between 25% and 8%.

As an indication of the kind of losses that can characterize a meltdown, Italian Prime Minister and media mogul Silvio Berlusconi lost more than 25% (or $2 billion) of his stock value with the 38% decline of the Italian stock market so far. In contrast, with the Chinese economy caught in a less ominous-sounding slowdown, according to Hurun's 2008 China Rich List the average wealth of China's 800 richest people declined by only 8% this year, and the compiler of the list concluded that China's rich are surviving the credit crunch in better shape than expected.

Yet as a palpable indication of the real impact of the global financial crisis on China, real estate estate heiress Yang Huiyan - the richest person in China last year - saw her wealth fall from $17.5 billion to $4.9 billion. And while the Chinese economy is currently seen to be slowing rather than melting, the plight of Yang Huiyan and other Chinese property developers in the current crisis forms part of a significant impact on China's real economy, reflected (as the Times put it) in human misery in real lives.

Yet much of the actual human misery in China associated with the crisis has fallen on the export manufacturing base in the Pearl River Delta, where an already dire situation has attained the features of a crisis. At least 2.7 million factory workers in southern China stand to lose their jobs after demand slowed considerably for electronics and toys. 9,000 of the 45,000 factories in the cities of Guangzhou, Dongguan and Shenzhen are expected to close down in the coming months. This year's orders from the US for Christmas products made by Chinese manufacturers have fallen off a cliff, and the latest CLSA China Manufacturers Purchasing Index (based on monthly questionnaires sent to 400 Chinese manufacturers), released in early October, indicated the steepest fall in the volume of both domestic and foreign orders since the survey began in June 2004.

52% of China's toy exporters, still reeling from inflated manufacturing and labor costs as well as a spate of recalls in 2007, have gone out of business in 2008, as have a number of Hong Kong-linked firms. One of the biggest of these was Smart Union Group and its Hejun Toy Factory in Dongguan, whose bankruptcy earlier this month was ascribed by local media to the firm's attempt to overcome tough export conditions by committing more resources while existing on loans. When Hong Kong banks tightened their credit facilities in the wake of the financial crisis, 7000 factory workers in China suddenly found the factory gates barred.

Yet if the financial crisis is wreaking havoc in southern China, Guangdong Vice Governor Wan Qingliang is not too ill-disposed to what's been going on. By emptying the cage for the new birds, as he put it, Wan sees the financial crisis as an opportunity to further the process of transplanting modern manufacturing into Guandong's melting low-value empire. And if the misery in Guangdong can be passed off as unavoidable growing pains, bringing hardship to millions yet ultimately facilitating modernization, then its fate is tied up with an historic turning point where the need for transition has become critical under the influence of the ongoing financial crisis. As China approaches 30 years of economic reform, the growth that has brought China this far needs to be reconstituted to shift the balance of the Chinese economy from FDI and exports to domestic consumption, services and innovation.

With the latest hardship brought on by the financial crisis, the suffering toy factories of Guangdong could become monuments to a China that is slowly fading from view: a China characterized by low-value industries and blemished by recalls of unsafe and poor quality products. Guangdong, once the harbinger of China's economic miracle and now caught up in the crunch of the financial crisis, could contribute to bringing the era of the dirt-cheap China price to a close by advancing China's transition to modern manufacturing. Yet in Guangdong, the current price to pay is an overbearing share of misery, for which the promise of the China of tomorrow is little solace.

Image from Mainstreetmeltdown.com, displaying an ice sculpture that was installed by two artists in New York's Manhattan financial district, slowly melting away as a monument to the plight of the US economy.

Since the advent of economic reform in China, Chinese exports as well as China's share of world exports have grown at a fast pace to surpass that of many developed economies. As a result, by the end of 2006 China had become the world's third-largest exporter after the US and Germany. In April 2008 the WTO announced that China had overtaken the US to become the world's second-biggest exporter, second only to Germany.

Yet the rise in China's exports has also been characterized by an important shift in its export structure. Where twenty years ago China was primarily an exporter of textiles, textile articles and apparel, today China is the world's largest exporter of electronics and machinery-related products, which make up 43% of China's total exports. China is rapidly moving up the technology ladder and is therefore becoming more competitive in exports of high-value capital goods - industries where traditionally Western countries such as Japan, Germany and the US have held the competitive advantage. But to what extent is China really able to compete with these countries today?

To better analyze this competitive landscape, we can make us of the industry classification of the OECD in its STAN Bilateral Trade Database, edition 2006, to compare Chinese and US high technology exports during the past few years.

According to the chart above, if we assume that the US' share of high-technology exports will continue the trend it has followed in the past 5 years, China's high-technology exports have already surpassed those of the US. So what does this mean? Is China the new high-technology power? Are there grounds for concern about China's threat to the competitiveness of Western industries?

I believe if these questions were posed to Laozi, the father of the yin yang concept, his answer would not be yes or no, and neither black or white, but rather a combination of both.

Yin: A sourcing opportunity rather than a threatAccording to OECD sources,

some 55% of China's total exports are attributed to production and assembly-related activities, and 58% of these are driven by foreign enterprises, of which 38% are entirely foreign-owned. In fact, among the top 10 high-technology companies by revenue, not one of them is Chinese.

China's export performance, therefore, is directly linked to its specialization in assembly operations and the high value-added inputs imported from Western economies. This has facilitated a rapid diversification of its manufactured exports, from low-end manufactures to high-technology products.

Yang: A sourcing opportunity but a future threatAlthough Chinese high-tech ability is still subsidized by foreign technology transfers and government support, Chinese companies are developing competitive advantages in several areas of high-value industrial and equipment manufacturing. Good examples are Huawei (a telecommunications equipment maker based in Shenzhen), whose equipment and services were considered good enough to beat Siemens in a German tender; Zhenhua Port Machinery, which had a full two-thirds of global port crane orders in 2006; and Tian Di Science & Technology, the national leader in the design and manufacturing of coal mining equipment.

To effectively make use of China's cost advantages as a high-technology assembly center, foreign companies will have to carefully consider to what extent and with which strategic framework technology transfers are implemented and imported inputs are assembled in China. At the same time, and considering China's evolving high-technology exports, trying to avoid China as a high-technology sourcing destination will likely result in an unfeasible cost structure and a loss of competitiveness. Successfully dealing with China's sourcing challenges and particularities will finally determine whether China is a threat or an opportunity.

I recently visited several steel mills. Above all esle, I found the mills were desperately in need of new orders.

Demand
from both the domestic and overseas markets began to shrink markedly
from August this year, and with the current financial crisis there is
no evidence to suggest that this trend will be reversed anytime soon.

Stockers
have been reducing new orders to steel mills, while at the same time
cutting prices by large percentages of up to 30%, until now. Some small
steel mills have been forced to close, and big mills have reduced
production. The related products include plates, coils, wires, welded
tubes and other lower value-added products.

Prices for hollow
bars, however, have dropped by 17% so far, on average less than the 12-30% drop of
other steel products. Hollow bars are a kind of seamless tube, widely
used in machinery industries and in the petrochemical industry, as well
as for boilers and power generation services. In the hollow bars market
there are fewer competitors, and it is a comparatively higher
value-added product. The overwhleming majority of hollow bars are sold
directly from the mills to the end-users in China and to overseas
buyers.

The current global financial crisis is reshaping the world's economies at various levels and it seems that no country in the world will be immune from the ripple effects. The lack of liquidity in global financial markets, combined with the drop in purchasing power is leading to a decrease in profits that are forcing many companies to re-evaluate and completely restructure their procurement strategies. In essence, the only way to keep profit margins at a healthy level - while at the same time remaining competitive in global markets - will be cutting costs and/or increasing revenues. It is within this space that new opportunities lie to source from or manufacture in China.

The potential benefits of sourcing from China are now more than ever becoming powerful, even necessary drivers for some companies to overcome the present difficulties. If approached correctly and strategically, China can be a solution that will not only help stabilize the present turbulence, but also establish a foundation for a more sustainable and profitable outcome by engaging the main components of the profit equation.

Access to a large potential market - Impressive economic growth throughout the years has given rise to a new Chinese middle class with increasing purchasing power. This factor, combined with the Chinese saving culture and low dependency on credit, has minimized the effect of the global financial crisis in China. Companies can take advantage of this and see China not only as a cost saving solution but also as a new source of revenue.

Competitive strategy - Many companies will accept that China is a viable solution in the current financial crisis, so quickly engaging the best Chinese suppliers before the competition reaches them will be instrumental to successful procurement strategies.

All of these benefits have been mentioned before, but for many companies the global financial crisis has transformed the benefits of sourcing from China into essential requirements for remaining competitive or even solvent in the global market.

*This is the second in our series of Chinese language
postings under the category 'Experiences in Dealing with Foreign
Traders' (外贸经验), aimed at Chinese suppliers. This posting is the second of five
parts setting out operational tips for Original Equipment Manufacturers
in China.

This posting launches a new section at the China Sourcing Blog entitled 'On the Ground,' which is written by members of the China Sourcing Unit of THE BEIJING AXIS and based on their direct experiences in conducting sourcing operations on the ground in China.

I am currently involved in some projects to assist foreign clients in sourcing machines and equipment from China, and I can share some of my experiences of the processes of delivery, installation and commissioning.

With the growth of China's equipment exports, the world is becoming more aware of China's relatively advanced technology and strong capacity to manufacture equipment, apart from China's traditional price advantage. However, when foreign buyers look closely at made-in-China equipment, they find that the problems lie in the details. Poor quality paint, bad welding and cuttings all reveal China's weakness in managing the details when compared to foreign brands. Even for packaging design, good foreign suppliers always fully consider users' convenience, while Chinese suppliers sometimes completely ignore the end-users' needs.

Chinese suppliers seem to care more about delivery times and schedules, which is why they can usually deliver on time. However, Chinese suppliers should learn to pay more attention to other factors. In my experiece, when installing and commissioning equipment in foreign factories, the process could often be suspended for safety reasons. Yet Chinese suppliers, if stopped from working, will complain about foreigners' over-cautiousness and 'low' efficiency.

Chinese suppliers are manufacturing equipment as sub-contractors under various world-class brands, i.e. Siemens, Demag, Danielle, etc. This is evidence of the growth of Chinese manufacturing capacity. Yet what Chinese suppliers still lack are 'soft skills' that would significantly improve professionalism and project management.

Briefing: Since 1957, the China Import and Export Fair, also known as the Canton Fair, has been held twice annually, in spring and autumn. It is China's largest trade fair, with the greatest variety of products and the largest attendance and business turnover.

* This is the first in our series of Chinese language postings under the new category 'Experiences in Dealing with Foreign Traders' (外贸经验) specifically aimed at expanding the focus of the China Sourcing Blog to Chinese suppliers. This posting is the first of five parts setting out operational tips for Original Equipment Manufacturers in China.

Economic logic dictates that if one does not manufacture where the production costs are the lowest, one may lose global competitiveness and therefore market share. Yet this is not only a question of low labour costs. Far from making a decision based upon a single criterion, entrepreneurs analyze a wider picture within which many other factors may influence the success of sourcing operations in a certain country. Such factors include set-up costs, labor supplies, export subsidies, import and export duties, tax incentives, proximity, country risk, political stability, the investment environment, abilities and qualifications of human resources, access to technology, infrastructure, logistics and consumption markets.

Labor costs are the lowest in countries such as the Philippines and Vietnam, for instance, yet the lack of existing infrastructure or an industrial base are likely going to increase the cost of business operations. On the other side of the spectrum, developed countries such as the US or Germany excel in modern transportation networks, but labor costs are extremely expensive and will predominate in an unfeasible cost structure.

In order to identify the best destination for a particular sourcing operation, one should firstly determine the critical performance indicators that may differ from country to country, and secondly compare those indicators between the selected potential sourcing countries. Following this logic one could build an 'Export Competitiveness Model' which could determine the likelihood of a successful managerial decision.

An enterprise would typically consider four critical performance indicators in its decision-making process:

Exports: The more a country exports the more competitive its production in global markets will be. A country with a high level of export implies a developed industrial base and related transportation infrastructure.

Labor costs: The lower the labor costs, the lower the production cost structure and therefore the larger the profit margin.

Country risk: The lower the country risk, the more sound and stable the legal environment will be to support business operations.

Political stability: The more politically stable a country is, the more sustainable its operations will be in the future.

As shown in the graph above, China's profile is the thinnest and hence China remains the most competitive. China's country risk and political stability index is higher than that of Germany or the US, but with much lower labor costs it reaches a very similar level of exports. In addition, there is little difference between China's country risk, political stability index and labor costs compared to those of Brazil and Thailand, yet its level of exports notably exceeds that of these developing economies.

Ultimately we can find many reasons to choose China as the most suitable sourcing destination. Yet the full answer depends not on one or two factors but on a combination of different factors that together create a favorable environment for sourcing operations.

The International Sourcing Fair was held at the Shanghai Mart from 23 to 25 October 2008. I was there early on the 24th.

The best thing about the fair was the 'reverse sourcing' model applied at the event, facilitating both buying and selling via bi-directional trading. This method was different from any other fair I have attended before as it reverses the normal pattern by making all the buyers sit behind booth while the sellers go around hunting for targets. There was also a wide range of products at the fair, from consumer and medical goods to industrial supplies.

Generally speaking, this kind of fair saves the buyer some time in not having to search for suppliers one by one, but the immense variety in products - which I originally considered a distinct advantage - made the fair look like a big grocery store. Given the limited space available, it would perhaps have been better to focus on a particular industry. From a sourcing point of view, it was hard if not impossible to identify good suppliers at the fair. Hence the hosts could consider setting parameters to filter suppliers by means of industrial rankings, sales volume or other standards, if they want to improve the fair and attract more buyers next year.

For more information on China sourcing events or assistance with attending any event in China, visit The Beijing Axis' homepage.

Times are changing at the China Sourcing Blog, and 'm happy to announce that this blog is about to be given a whole new lease of life.

Processes have finally been put in place for CSB to feature regular contributions from The Beijing Axis' China Sourcing Unit members, in the shape of 'on the ground' China sourcing knowledge emanating from their daily experiences of working in the field. We will also feature a new Events section to highlight upcoming sourcing fairs, as well as a Knowledge section to review the latest and best knowledge sources related to China sourcing. And of course we will continue to do what we have always done at CSB: Analyze, discuss, distill, dissect and probe this thing called China Sourcing.

Apart from all the additions mentioned above, we will also be piloting a new Chinese-language section on the blog aimed at Chinese suppliers.

With this we are slowly coming of age at CSB, and becoming what we have always meant to become: THE China Sourcing Blog.